What’s Next: Producers’ Ability to “Just Say No” to Gas Gathering Agreements in Bankruptcy

Our recent post, “Gas Agreements Rejected For Not Running With Land,” described decisions of the Delaware bankruptcy courts concluding that upstream producers in Wyoming and Colorado could reject gas gathering agreements, including the gas dedication and minimum volume commitments.  In re Extraction Oil & Gas, Inc., No. 20-11548 (CSS), 2020 WL 6694354 (Bankr. D. Del. Oct. 14, 2020); In re Southland Royalty Co. LLC, No. 20-10158 (KBO), 2020 WL 6685502 (Bankr. D. Del. Nov. 13, 2020).  These decisions have the potential to reshape the midstream industry and, in turn, dramatically affect upstream exploration and development.

The bankruptcy judges both observed the difficult policy decisions at stake.  On one hand, the obligations and burdens of a gas gathering agreement can be a significant—or even the primary—reason that a producer declares bankruptcy.  Of course, bankruptcy law and policy encourage the bankrupt entity to either emerge as a viable entity after restructuring or sell assets as a means to, at least partially, pay creditors.  If a gas gathering agreement significantly burdening the assets survived bankruptcy without modification or rejection, then it is difficult or impossible for a viable entity to emerge or the assets to be sold, frustrating the very purpose of the bankruptcy.

On the other hand, midstream companies make major, upfront financial commitments to build the gas gathering infrastructure and processing facilities necessary for the upstream producers to move their gas from the wellhead to market.  In the Extraction and Southland Royalty decisions, the midstream companies vehemently argued that they had only made these significant infrastructure investments because their gas gathering agreements would run with the land. That key covenant allows the midstream company to recoup their investment over time.   If the bankruptcy process allowed the upstream producers to reject their gas gathering agreements, the midstream companies would not take the financial risk to invest in the infrastructure necessary to move the production to market.  The midstream companies argued such a policy decision would stifle exploration and development.  Indeed, this bankruptcy issue poses a real threat to the current model for midstream development.  If nothing else, this vulnerability may make new development more expensive.

Again, both decisions recognized the dilemma, yet sided with the bankrupt producer. But both judges did so narrowly, relying on a comprehensive examination of property law in the respective states in light of the particular agreement terms at bar.  As such, the decisions are a potential watershed moment in that gas gathering agreements can be subject to rejection despite intense effort from midstream entities to avoid that fate both in drafting and in court.

At the same time, however, careful drafting can address and avoid at least some of the grounds on which these bankruptcy judges rendered their decisions.   Drafters of gas gathering agreements should carefully research and address applicable property law, which varies in material ways by state.  For example, parties may need to negotiate some restriction or interest that grants the midstream producer some control over what the producer does with the mineral estate, thereby meeting the touch and concern and privity requirements necessary to create a real covenant in states like Colorado and Wyoming.  Additionally, drafters should ensure that any clauses which they would like to run with the land clearly state that intent, without depending on the gas dedication clause to support the remaining terms.

Going forward, these decisions may be resolved by settlement between the particular parties or appealed.  Indeed, prior cases had upheld similar covenants, generating the type of trial court split that appellate courts frequently step in to decide.  E.g., Alta Mesa Holdings, LP v. Kingfisher Midstream, LLC, 613 B.R. 90 (Bankr. S.D. Tex. 2019); Monarch Midstream, LLC v. Badlands Prod. Co., 608 B.R. 854 (Bankr. D. Colo. 2019).  But the lessons will remain: drafters should recognize the vulnerability of gas gathering agreements to rejection in bankruptcy—and the negotiating leverage which comes with that—but also that the midstream industry will not abide by the status quo ante, probably requiring largely new terms in future gas gathering agreements.

Tags:  Bankruptcy, In re Extraction Oil & Gas, Inc., In re Southland Royalty Co. LLC, gas gathering agreements, real property covenants, covenants running with land